Raytheon 2012 Annual Report Download - page 42

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value of contracts awarded for which work has not been performed. Backlog generally increases with bookings and generally
converts into sales as we incur costs under the related contractual commitments. We therefore discuss changes in backlog,
including any significant cancellations, for each of our segments, as we believe such discussion provides an understanding
of the awarded but not executed portion of our contracts. As described in Commitments and Contingencies, beginning on
page 72, in the second quarter of 2010, Raytheon Systems Limited (RSL) was notified of its termination on the U.K. Border
Agency (UKBA) program, which resulted in a net backlog adjustment of $556 million at IIS.
Total net sales were $24.4 billion, $24.8 billion and $25.2 billion in 2012, 2011 and 2010, respectively.
Operating income was $3.0 billion, $2.8 billion and $2.6 billion in 2012, 2011 and 2010, respectively. Operating margin was
12.2%, 11.4% and 10.4% in 2012, 2011 and 2010, respectively. Included in operating income was the FAS/CAS Adjustment,
described below in Critical Accounting Estimates, of $255 million, $337 million and $187 million of expense in 2012, 2011
and 2010, respectively.
Operating cash flow from continuing operations was $2.0 billion, $2.1 billion and $1.9 billion in 2012, 2011 and 2010,
respectively.
A discussion of our results of operations and financial condition follows below in Consolidated Results of Operations; Segment
Results; Financial Condition and Liquidity; and Capital Resources.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are based on the application of U.S. Generally Accepted Accounting Principles (GAAP),
which require us to make estimates and assumptions about future events that affect the amounts reported in our consolidated
financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore,
the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any
such differences may be material to our consolidated financial statements. We believe the estimates set forth below may
involve a higher degree of judgment and complexity in their application than our other accounting estimates and represent
the critical accounting estimates used in the preparation of our consolidated financial statements. We believe our judgments
related to these accounting estimates are appropriate. However, if different assumptions or conditions were to prevail, the
results could be materially different from the amounts recorded.
Revenue Recognition
We determine the appropriate method by which we recognize revenue by analyzing the type, terms and conditions of each
contract or arrangement entered into with our customers. The significant estimates we make in recognizing revenue for the
types of revenue-generating activities in which we are involved are described below. We classify contract revenues as product
or service according to the predominant attributes of the relevant underlying contracts unless the contract can clearly be split
between product and service. We define service revenue as revenue from activities that are not associated with the design,
development or production of tangible assets, the delivery of software code or a specific capability. Our services sales are
primarily related to our TS business segment.
Percentage-of-Completion Accounting—We use the percentage-of-completion accounting method to account for our long-
term contracts associated with the design, development, manufacture, or modification of complex aerospace or electronic
equipment and related services, such as certain cost-plus service contracts. Under this method, revenue is recognized based
on the extent of progress towards completion of the long-term contract. Our analysis of these contracts also contemplates
whether contracts should be combined or segmented in accordance with the applicable criteria under GAAP. We combine
closely related contracts when all the applicable criteria under GAAP are met. The combination of two or more contracts
requires judgment in determining whether the intent of entering into the contracts was effectively to enter into a single project,
which should be combined to reflect an overall profit rate. Similarly, we may segment a project, which may consist of a single
contract or group of contracts, with varying rates of profitability, only if the applicable criteria under GAAP are met. Judgment
also is involved in determining whether a single contract or group of contracts may be segmented based on how the arrangement
was negotiated and the performance criteria. The decision to combine a group of contracts or segment a contract could change
the amount of revenue and gross profit recorded in a given period.
The selection of the method by which to measure progress towards completion of a contract requires judgment and is based
on the nature of the products or services to be provided. We generally use the cost-to-cost measure of progress for our long-
term contracts unless we believe another method more clearly measures progress towards completion of the contract. Under
the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred